Red Capitalism: The Fragile Financial Foundation of China's Extraordinary Rise by Carl E. Walter
My rating: 4 of 5 stars

How Goldman Sachs Captured China

It is difficult to overestimate the power of financial theory as a social ideology. This book is a demonstration of that remarkable power in the most unlikely political environment: China. Walter and Howie unravel the apparent mystery of how a Communist, indeed a Maoist, state has transformed itself into a capitalist society in the course of a single generation. Neither Lenin nor Mao conceived of any such evolution.

So where did the Chinese programme originate and what is the intellectual framework that provides such extraordinary cohesiveness during this profound social transition? Walter and Howie provide an answer which many will find surprising: "The New China of the 21st century is a creation of the Goldman Sachs and Linklaters & Paines of the world just as surely as the Cultural Revolution flowed from Chairman Mao's Little Red Book....if there is a single reason why the world is in awe of China's economic miracle today, it is because international bankers have worked so well to build its image so that minority stakes in its companies could be sold at high prices, with the Party and its friends and families profiting handsomely."

The authors also recognise however that even the power of international investment banks and corporate law firms on its own is insufficient to motivate over 1 billion people to accept this image without protest. What is needed is a theory, a theory which in itself is neither socialist or capitalist, a theory which purports to be an unbiased account of the way the world really is and provides coherent guidelines for coherent action. Enter modern financial theory. Based on the need by early 20th century robber barons in the US to provide a rational for their machinations to control transport and commodities, financial theory makes an ingenious play.

Unlike liberal economic theory and with complete disregard for the niceties of accounting, financial theory employs a specific and irrefutable criterion of value. This criterion is neither the market nor the result of any disciplined analysis of what the results of commercial transactions have been. Rather, for finance, value is a matter of expectations about the future, what I or you, or a CEO or a Politburo member thinks could happen over some indefinitely long period in the future.

You and I may not have the power to impose our view of the future on others but CEO's and Politburo members do. And in the name of financial rationality they do this as a matter of course in the modern world. It is finance which provides the mechanism for transforming political power into economic power.

The case of the China Mobile flotation, at the time the largest stock market entry ever undertaken is demonstrative: "The key point that stands out in the (China Mobile) transaction is that a subsidiary raised capital to acquire from its parent certain assets by leveraging the FUTURE VALUE of those same assets as if the entire entity - subsidiary plus parent assets - existed and operated as a real company. The value of the provincial assets, as far as the IPO goes, was based on projected estimates of their future profitability as part of a NOTIONAL company that was compared to the financial performance of EXISTING national telecomm companies operating elsewhere in the world." In other words, the authors continue: "The valuation of such assets was purely a matter of China's negotiating skills, flexible valuation methodologies employed by the investment banks, and demand in the international capital markets."

All this might seem vaguely familiar to economists and other corporate-watchers. It is precisely the corporate tactic of Enron, orchestrated by precisely the same bankers and lawyers. Even the accounting is similar: recognise results in excess of declared expectations, and bury disappointing results in subsidiary accounts. And just as with Enron, the bubble can continue to expand without limit...until it finally bursts. When it does be quite sure that Goldman Sachs has already shorted the entire Chinese economy.

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